DIVERSIFICATION STRATEGY

Group 5

1. Definition of Diversification strategy

A diversification strategy is a business growth strategy used by a firm. This approach
entails broadening the organization's coverage across several goods and market segments.
The approach is to enter a new market or industry in which the organization does not
already operate, while also developing a new product for the new market.
- Related diversification: There is the possibility of realizing synergies between the
present business and the new market.
Example: A leather shoe manufacturer, that launches a line of leather wallets or
accessories is following a related diversification strategy.
- Unrelated diversification: There are no possible synergies between the present business
and the new market to be developed.
Example: A leather shoe manufacturer who begins producing phones is following an
unconnected diversification strategy.
There are 6 types of this strategy:
- Concentric Diversification
- Conglomerate Diversification
- Horizontal Diversification
- Vertical Diversification
- External Diversification
- Internal Diversification
Some companies which are applying diversification strategy:
+ Apple: from computers to MP3 players and phones
+ Disney: from cartoons to cruises, theme park and media
+ Estée Lauder: cosmetics, personal care and perfumes
+ Pepsi and Coca-Cola: beverages to snack and energy drinks

2. Concentric and Conglomerate Diversification

a. Concentric Diversification
- Concentric diversification occurs when a company enters a new market with a new
product that is technologically similar to their current products and therefore are able to
gain some advantage by leveraging things like industry experience, technical know-how,
and sometimes even manufacturing processes already in place. Concentric diversification
can be beneficial if sales are declining for one product, as loss in revenue can be offset by
a rise in sales from other products.
- Example: Apple. Inc who diversified from clunky desktop PCs into laptop production.
From Apple LISA - bulky to Macbook - compact. This would allow them to immediately
take advantage of the new wave of computer users who demanded more portable
solutions.
b. Conglomerate Diversification
- If you’re looking to diversify into completely new markets with unrelated products to
reach brand new customer bases, this is known as conglomerate diversification. The term
conglomerate refers to a single corporate group operating multiple business entities
within entirely different industries. The parent company that owns all of the individual
entities is known as a conglomerate, and it became one by successfully implementing a
conglomerate diversification strategy.
- Example: Tata Group, which was founded in 1868 and diversified from its humble
beginnings as a hotel company into a global multinational encompassing 100 individual
companies. It now employs 706,000 people across a variety of sectors such as chemicals,
steel, automotive, engineering, telecommunications, information systems, and
consumables.

3. Horizontal versus Vertical Diversification

a. Horizontal Diversification
Horizontal diversification is when a business introduces different and unrelated
products/services. The goal of launching the related product is to satisfy the needs of
customers. It involves a limited amount of risk because you’re dealing with the same
customer market.
Example: The Walt Disney Company and 21st Century Fox
- The Walt Disney Company's acquisition of 21st Century Fox was finalized in March
2019. The goal of the merger was to increase Disney's content and entertainment options
to satisfy consumer demands, expand into the international market, and expand its direct-
to-consumer offerings, including ESPN+, Disney+, and the two company's combined
ownership stake in Hulu.
- The acquisition also included Twentieth Century Fox, Fox Searchlight Pictures, Fox
2000 Pictures, Fox Family and Fox Animation, Twentieth Century Fox Television, FX
Productions and Fox21, FX Networks, National Geographic Partners, Fox Networks
Group International, Star India, and Fox’s interests in Hulu, Tata Sky and Endemol Shine
Group.

b. Vertical Diversification
Vertical integration or vertical diversification is when a business integrates two or more
production processes by moving up/down the supply chain. The company takes control
over some of the core production, distribution, raw material, and assembly line processes.
Example: Netflix Produces Its Own Content
- Netflix is one of the most significant examples of vertical integration in the
entertainment industry. Prior to starting its own content studio, Netflix was at the end of
the supply chain because it distributed films and television shows created by other content
creators. However, Netflix leaders realized they could generate greater revenue by creating
their own original content. In 2013, the company expanded its original content offerings.

4. Internal and External Diversification

a. Internal Diversification: when a business launches its current/existing product into the
new market. The goal is to increase the customer market by expanding the geographic
borders. Companies do it by locating the new users of their existing products/services.
Internal diversification is also about introducing a new product to the current market.
Businesses use their existing distribution channel to launch a new product.
- Example: Fast-food companies have started offering low calories and salt-free food items
to the current product line. McDonald’s has a surprisingly good variety of low sodium fast
food options that contain less than 500 mg of sodium per serving.

b. External Diversification: when a business launches a new product/service by going out

of its current business operations. A merger is also a form of external diversification when
two companies integrate their business operations to create something new. The merging
companies usually comprise of a similar size. The acquisition is also the second form and
type of external diversification where one company buys another. The acquired company
loses its identity and completely absorbs the buyer company.
- Example: Like the recent $2.35 Billion acquisition of 3par by HP would enhance HP’s
storage portfolio as 3 par being the leader in the enterprise storage products will give HP
an edge in the cloud computing markets over its rivals. HP acquired a company that would
add European Scientific Journal 45 value to its end product. In this way, companies can
take advantage of other company’s experience and expertise by purchasing its stock. HP
and Compaq got merged in 2002 with HP paying $25 billion to Compaq in an attempt to
capture a major chunk of the PC market.

5. Pros and Cons of Diversification Strategy

a. Pros
1. It eliminates the normal economy's cyclical character.
Economies develop and deteriorate. People's spending patterns shift as a result of this.
When money is tight, fewer people will buy new automobiles, and fewer people will take
out new mortgages. Luxury things are more likely to be acquired when money is more
readily available. Because a small portion of a portfolio is invested in a variety of
businesses, diversification helps a portfolio to weather these cycles because certain items
are always up while others are always down.

2. Unpleasant shocks are unavoidable.

A promised medical breakthrough does not occur as planned. The mining corporation
with steady returns suffers an unexpected collapse at one of its locations. Even leaders
like Steve Jobs may cause doubt when physical difficulties interfere with their
effectiveness. The simple fact is that every investment might be hit by a nasty surprise.
Diversification can assist to alleviate the financial impact of negative news.

3. Diversification is made simple for the casual investor by certain investments.

Vanguard is an excellent illustration of this. For the casual investor seeking a diversified
portfolio, there are four major ETF possibilities. You have the choice of investing in the
entire stock market, foreign stocks, total bonds, or total international bonds. This can
assist investors in refraining from chasing returns, which may result in them overlapping
their assets more than they plan.

4. Diversification assists in making the most use of potentially underused resources.

Occasionally, an investment does not perform as expected. It's similar to a company
expecting a product to perform one way, but the data indicate that it behaved very
another. With the correct approach, these under-performing components of a portfolio
may be liquidated and then re-invested in diversified components with a demonstrated
track record of performance. More money can increase over a longer period of time as a
result.

5. Growth is built on the knowledge and experience of others.

Although you must conduct due diligence to determine which industries tend to be up
when others tend to be down, it is often the extent of what the casual investor needs to do
for work other from examining the dependability of organizations. Investors rely on the
knowledge of others to allow their money to grow, which allows everyone to focus on
their primary talents rather than pretending to be something they are not.

6. It offers migration away from potentially decreasing activities.

Economic reasons might lead an industry to decline for a period of time. Then there are
occasions when an industry is entirely wiped out. After all, when was the last time you
bought a yoke and plow for your livestock? Diversification helps investors to shift away
from activities that may be losing money so that their strategy may always generate some
type of growth.

b. Cons
1. It automatically restricts your prospects for advancement.
When investors are ready to take significant risks, they have the opportunity to reap large
rewards. Diversification is a cautious investing strategy, therefore any profit potential is
inevitably restricted. You will make more money if you are entirely involved in a sector
of the economy that is seeing remarkable growth than if you have a balanced portfolio.
2. Even diversity might result in a loss of money over time.
Many investors will hold bonds in their portfolios to assist counter any widespread stock
market drops that may occur. The only difficulty with this is that even municipal bonds,
which are nearly as safe as they come, might lose money if their credit status changes or
if suspicious actions occur that need an inquiry.
3. Some ETF investments for diversity are excessively diverse.
When asset classes monitor too many distinct assets, the investment expenses become
problematic. When attempting to diversify, investors should be skeptical of anything that
appears too good to be true. Some alternative mutual funds can outperform Vanguard, but
in the Vanguard example, those four choices aren't available to individual investors
because of their high prices.
4. There may be unanticipated tax ramifications.
If you invest in gold ETFs, for example, the profits from the purchasing and selling
process are taxed at capital gains rates - which were 28 percent at the time of writing.
Other income may be taxed at either a 15% or a 20% rate, depending on personal income
levels. That is why, when it comes to diversification, the greatest advice is to avoid
investing in anything that is not thoroughly understood.
5. It complicates the investing process.
If you have $200,000 to invest, it is far easier to put it all into one investment. If you
divide it into ten $20k investments, you'll have ten firms to undertake due research on.
This means that not only will the portfolio become more complicated, but there will also
be additional administrative and bureaucratic expenditures that must be borne in order to
keep the assets in place over the long term.
6. Political and legal factors might have an impact on an investor's life.
Rupert Murdock is a good illustration of this. He obtained US citizenship in 1985 since
non-US citizens could only possess a maximum of 25% of any corporation with a
broadcasting license. His method effectively compelled him to embrace citizenship.
Although this is an extreme scenario, the same basic idea applies to all investors. Political
and legal sway may be expensive in a variety of ways.